by Jake Moeller.
Jake Moeller examines the debtor profiles of the U.K. and European high-yield and strategic bond fund sectors.
In last week’s Monday Morning Memo, my colleague Detlef Glow reviewed the “liquidity riddle” in high yield bond funds. Discussions on bond fund liquidity are certainly becoming more common among investors as money continues to pour into the asset class.
And this is as it should be – large flows have forced the hands of many bond fund managers to seek ways to fully invest them. Increasingly bigger funds contain more securities, and often managers are forced to move around the credit spectrum to maintain a decent yield in a world where compression has become the norm. Have these flows caused a material increase in credit risk for bond funds? It is worth examining some bond sectors to see to which credit buckets U.K. and European bond fund managers are concentrated:
Looking at the Investment Association (IA) Sterling High-Yield Bond sector: As of July 31, 2015, the highest average allocation was in B-rated credit (39.9%) followed by BB (35.5%). Twelve months ago, these allocations were 37.0% and 32.6%, respectively. Five years ago (to the period ended July 31, 2010) the average sector exposure to B-rated securities was 23.4% with 18.3% to BB-rated securities. For 2015, average exposure to A- or better- rated securities was 11.0% but for 2014 this figure was 8.0% and for 2010, 11.7%. The balance between investment- and non-investment grade overall has moved up for 2015, a total of 16.6% in investment-grade – up from 14.3% for 2014 and down from 17.6% for 2010. The most significant change over the last twelve months has been the drop in aggregate exposure to riskier unrated securities: 7.1% for 2015 down from 14.8% for 2014 and 31.9% for 2010. This appears to have funded the commensurate increase in non-investment-grade securities.
Sterling Strategic Bond
In the “go anywhere” IA Sterling Strategic Bond sector, the highest aggregate concentration for 2015 is in BBB-rated securities (23.8%) followed by BB-rated (14.5%). For 2014, this pattern was maintained, with 22.1% and 13.3%, respectively. For 2010, portfolios in this sector contained an average of only 13.6% in BBB-rated securities, with the highest allocation being to AAA-ratings (15.6%). However, the overall aggregate exposure to investment-grade credit for 2015 was 59.8%. For 2014 this figure was 60.2% and for 2010 only 44.3%. Aggregate exposure to unrated securities in this sector was 9.7% for 2015, down from 10.1% for 2014 and 33.1% for 2010.
European High Yield
In the Lipper Global – Bond Europe High-Yield sector, the highest aggregate exposure was to BB-rated securities (33.9%), followed by B-rated (30.7%). For 2014, these allocations were 30.0% and 32.5%, respectively. For 2010, these sectors again proved most popular with 23.7% in BB-rated and 25.6% in B-rated. For 2015, total exposure to investment-grade credit in aggregate was 8.9%. For 2014, this was 7.14% and for 2010, 10.7%. Patterns in changes to unrated securities exposure have been consistent with the other sectors. For 2015, the aggregate exposure to unrated was 15.4%, down from 2014 (16.7%) and halved from 2010 (29.0%).
Table 1. Comparative Debtor Quality Profiles of Bond Fund Sectors
In aggregate, over the last 12 months and compared to five years ago, it appears corporate bond fund managers in the higher-risk bond sectors have not materially decreased the quality of their portfolio holdings. This is despite the demand from investors for yield. European bond managers appear willing to have a higher exposure overall to non-investment grade debt, than their U.K. counterparts but they still exhibit a relative improvement in their aggregate debtor profile.
While this might provide investors some comfort, it should be noted that there is considerable variation of credit exposures among individual fund managers: one fund in the European High Yield sector, for example, has 65% exposure to unrated securities. It is important for investors to keep an eye on the most recent fact sheet to see where a fund manager is exposed. Furthermore, an aggregate increase in debtor quality will be of only limited assistance to investors in the event we see a mass rotation out of high-yield bond funds.